lecture notes

Lecture notesPrepared by Anton

Ljutic

© 2004 McGraw–Hill Ryerson Limited

Aggregate Expenditure

CHAPTER SIX


• Distinguish between autonomous and induced expenditures

• Understand the concept of expenditures equilibrium

• Explain what factors can affect spending and how they can affect income

• Describe how small changes in spending have a large effect on national income

• See the significance of the Keynesian revolution

This Chapter Will Enable You to:


Quick review/definitions

• GDP = national income = Y

• AE = aggregate expenditure =

• Question: does AE always equal Y?

C + I + G + Xn


The Expenditure Model (I)

• Autonomous spending– The portion of total spending that is

independent of the level of income

• Induced spending– The portion of spending that depends on the

level of income

• Aggregate expenditures = autonomous + induced


The Expenditure Model (II)

• Marginal propensity to expend– The ratio of the change in aggregate

expenditure that results from a change in income

• Marginal leakage rate– The rate of change of leakages that result from

a change in income

MPE = aggregate expenditures / income

MLR = total leakages / income

MLR = 1 - MPE


The Tax Function and Disposable Income

• It shows the relationship between taxes and income – Marginal tax rate

• The ratio of the change in taxation as a result of a change in income

• To calculate it, you divide the change in taxes by the change in income

– Disposable income• It is national income minus taxes (Y - T)

• Total taxes = autonomous taxes + induced taxes


The Consumption Function

• Autonomous consumption– The portion of consumer spending that is independent

of the level of income

• Induced consumption– The portion of consumer spending that is dependent on

the level of income

• Marginal propensity to consume– The ratio of the change in consumption to the

corresponding change in income

MPC = consumption / income


The Saving Function

• S = Yd – C

• Yd = C + S

• Marginal propensity to save (MPS)– The change in savings as a result of a change in

disposable income or national income

MPS = saving / income


The Consumption Function

•As disposable income rises,consumption also rises•The slope of the consumption function is the MPC

•As disposable income rises,consumption also rises•The slope of the consumption function is the MPC

Income

CC

Autonomous consumption


The Saving Function

S

Income

S

The slope of the savingfunction is the MPS

The slope of the savingfunction is the MPS


The Investment and Government Spending Functions

I & G

Income

I

G

NOTE: Model assumes that both Investment and Government spending functions are autonomous

NOTE: Model assumes that both Investment and Government spending functions are autonomous

Figure 6.2


Exports, Imports and the Net Export Function

• Net Exports– It is assumed that exports are autonomous whereas

imports are directly related to national income– Marginal propensity to import (MPM)

• The change in imports as a result of a change in national income

– Balance of trade• The value of a country’s export of goods and services less the

value of imports

MPM = imports (IM) / income (Y)


Expenditure Equilibrium

• …is that level of income (and production) at which there is neither a surplus nor a shortage of goods and unplanned investment is zero

• Unplanned investment: the amount of unintended build-up or run-down of business inventories (= Y-AE)


The Aggregate Expenditure Function

•The slope of the aggregateexpenditure function is the MPE •It is equal to the slope of the consumption function (MPC) minus the slope of the net export function (MPM)

•The slope of the aggregateexpenditure function is the MPE •It is equal to the slope of the consumption function (MPC) minus the slope of the net export function (MPM)

AE

Income

AE

C

XnFigure 6.4


Expenditure Equilibrium (Graph)

AE

Y

AE

AE=Y

G + I + X

T + S + IM

Y

Shortage

Surplus

Figure 6.5


The Net Export Function

X, IM

XN=X-IM

X

IM

Income

Trade

+

-

Figure 6.3


From Income to Disposable Income

• Disposable income– It is national income minus total taxes (Y - T)

• Total taxes = autonomous taxes + induced taxes

• Marginal tax rate– The ratio of the change in taxation as a result of

a change in income

MTR = taxes / income


Where Income Goes

MPC = (1 – MTR) x MPCD

MPCD = consumption / disposable income

MPE = MPC - MPM


Autonomous and Induced Spending (I)

Y

AEY=AE

AE

Spending

(effect)

Income (cause)

Figure 6.7A


Autonomous and Induced Spending (II)

Y

AEY=AE

AE

Autonomous spending (cause)

Level of

Spending

(effect) Figure 6.7B


A Change in Autonomous Consumption

• Changes in wealth– Wealth effect

• The effect of a change in wealth on consumption spending

• Changes in the price level– Real-balances effect

• The effect that a change in the value of real balances has on consumption spending. The value of real balances is affected by changing price levels

• Changes in the age of consumer durables• Changes in consumer expectations


A Change in Investment

• Interest rates

• Purchase price, installation, maintenance and operating costs of capital goods

• The age of capital goods

• Business expectations

• Government regulations


A Change in Government Spending

• Tax revenues

• Interest rates

• Social and cultural standards

• Voters’ expectation

• Budget philosophies

• Political considerations


A Change in Autonomous Net Exports

• Comparative price levels

• The value of exchange rates– Exchange rates

• The value of a country’s currency in relation to foreign currencies

• Income levels abroad


The Model’s Algebra

• Assume:C = 170 + 0.75 YD and T = 160 + 0.2 Y

C = 50 + 0.6 Y

I = 250

G = 400

XN = 100 – 0.1 Y


The Multiplier (I)

• The effect on income of a change in autonomous spending

• The value of the multiplier depends on the MPE

• In general, a one dollar increase in autonomous spending will lead to more than a dollar increase in income


The Multiplier (II)

AE

Income

AE2

AE1

Y=AE

Shortages

cause

result

Figure 6.8


The Multiplier (III)

• An increase in investment will lead to an increase in income, which will in turn lead to an increase in consumption

Multiplier = income / autonomous expenditures

Multiplier = 1 / (1 – MPE)

or 1 / MLR

or 1 / MPC - MPM

The higher the MPE, the higher the multiplier.


The Model’s Algebra

• Assume:C = 50 + 0.6 Y

I = 250

G = 400

XN = 100 – 0.1 Y

• Then…AE = Y = C + I + G + XN

= 50 + 0.6Y + 250 + 400 + 100 – 0.1Y

0.5Y = 800

Y = 1600


Summing up (I)

• Income will increase if one of the following increases:– Autonomous consumption

– Investment

– Exports

– Government spending

• Income will increase if one of the following decreases:– Autonomous taxes

– Autonomous imports


Summing up (II)

• The value of the multiplier will increase if any of the following decreases:– Marginal propensity to save (MPS or MPSD)

– Marginal tax rate– Marginal propensity to import


A Look at Keynesian Revolution

• The Great Depression and the low employment equilibrium due to shortage in purchasing power

• Keynes’ prescription: that the government borrow and spend, increasing autonomous expenditures and boosting incomes (and therefore purchasing power and consumption)


Derivation of the Aggregate Demand Curve

AE2

AE1AE3AE

Y1Y2 Y3

Y

P2

P1

P3AD


• A change in expenditure can be autonomous or induced

• Expenditures are in equilibrium when they equal income and there is no unplanned investment

• Many factors can affect spending and therefore income. Can you list and explain them?

• Describe how small changes in spending have a large effect on national income

• Summarized the significance of the Keynesian revolution

Chapter Summary:What to Study and Remember

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